5 Big Trades From the Financial Sector - views

BALTIMORE (Stockpickr) -- If 2012 has been a good year for stocks so far, it’s been a stellar year for the financial sector.

While the S&P 500 has rallied nearly 15% since the start of the year, financial stocks have managed to do one better, spurring a massive 23% climb in the SPDR Financial Select Sector ETF (XLF) over that same period. The S&P’s returns are certainly nothing to besmirch this year -- it puts 2012 in the top quartile of return years going back to the index’s creation -- but the rally in financial stocks has been materially stronger than that. Now the question is whether the run in financials can continue in 2012.

Investors should expect earnings to play a big role this week, but a handful of financial sector trades already in play are already worth watching. That’s why we’re taking a technical look at charts of five financial names you need to see.

For the unfamiliar, technical analysis is a way for investors to quantify qualitative factors, such as investor psychology, based on a stock's price action and trends. Once the domain of cloistered trading teams on Wall Street, technicals can help top traders make consistently profitable trades and can aid fundamental investors in better planning their stock execution.

First up is insurance giant American International Group (AIG). As impressive as the price performance of the financial sector has been in 2012, AIG shareholders have managed to outperform even that. Shares of this $62 billion company have rallied more than 56% since the first trading day of January, and now AIG’s chart is indicating even higher ground for the final quarter of 2012.

That’s because AIG is currently forming an ascending triangle pattern, a setup that’s formed by a horizontal resistance level to the upside, and uptrending support below shares. Essentially, as AIG’s price bounced in between those two technically important levels, it was getting squeezed closer and closer to a breakout above $35 resistance. That breakout finally happened last week.

Since then, shares have been consolidating, giving buyers a chance to catch their breath after pushing AIG’s price through a level that’s previously acted like a ceiling for shares. Momentum, measured by 14-day RSI, has been trending higher as over the last several months, a factor that adds some extra significance to the breakout in AIG. Since momentum is a leading indicator of price, the momentum uptrend means that AIG’s price is still increasing at an increasing rate right now.

Like AIG, Federated is forming an ascending triangle setup, with a horizontal resistance level at $22 and uptrending support below shares. The pattern in shares isn’t the most important thing about this setup, though. When you’re looking at price patterns, it’s important to think about them in real terms, not in terms of geometric shapes; after all, those shapes may be a good way of describing the pattern, but they don’t answer why it matters.

For FII, the strong resistance level at $22 is a price level above which there’s a glut of supply of shares. In other words, it’s a price where sellers have recently been more eager to sell and take gains than buyers were to keep buying.

That said, uptrending support at the bottom of the pattern does indicate that buyers have control of shares at lower price levels. If they can manage to spur a move above $22, it means that the excess selling pressure has been absorbed by increasingly eager buyers and that it makes sense to jump in. After all, the ideal time to buy is when sellers have gotten taken out.

Back in March, shares hit a higher resistance level at $23 (marked by the dashed horizontal line), but I don’t think traders need to worry too much about hitting more resistance there. It’s likely those are the same sellers who created resistance at $22, but they opted to lower their asks after the correction this Spring.

As with AIG, when the breakout happens, keep a tight stop on Federated Investors.

American Express

American Express (AXP) is forming a triangle of a different sort right now. Like the other names on our list, American Express has been on a tear in 2012, rallying more than 23% as improving consumer sentiment spurred bigger dollar volume flowing through AXP’s payment network. This fall, the symmetrical triangle in shares of AXP points to higher prices for the firm.

A symmetrical triangle is a price pattern that’s formed by converging resistance and support lines that are moving towards price at approximately the same rate. Old-school technicians often call the symmetrical triangle a “coil,” because price action within the pattern typically resembles a tightening spring. Like a spring, the breakout from a coil pattern tends to be sharp and quick.

That makes a lot of sense. After all, over the course of a symmetrical triangle, volatility is slowly diminishing and the average daily range of American Express is getting smaller and smaller. But volatility is cyclical, so a period of very low volatility is a contrarian indicator that points to a big move.

With an uptrend in AXP’s price action preceding the pattern, an upside breakout is the likeliest move for shares. That said, it’s critical to wait for the breakout to actually happen before buying this trade.

Wells Fargo

Not all of the setups we’re looking at this week are positive. The sole downside trade on our list is Wells Fargo (WFC), the big bank that’s been such a Wall Street darling of late.

Despite Wells’ fundamental status as the best of the big banks, this stock is looking technically weak right now after triggering a double top pattern. Here’s how to trade it.

Wells made two tops at the $36.50 level, a reversal pattern that became a sell signal once WFC broke down through the horizontal support line on the chart above. Investors have October 12 earnings to thank for the breakdown. While the relatively small height of the tops means that WFC’s downside target is pretty nearby, it’s not uncommon for short-term reversal patterns to spur on longer-term reversals. If you’re looking for a buying opportunity in Wells, I’d recommend sitting tight until this stock can find its next closest support level.

Shorts still have some high-probability downside left in this WFC trade. If you decide to bet against shares, I’d suggest keeping a tight stop just above the 50-day moving average.

Last up is mid-cap insurance firm Aspen Insurance Holdings (AHL). Aspen has been locked in an uptrending channel for all of 2012, rallying higher in between well-defined trend line resistance and trend line support levels. Those boundaries make it significantly easier to spot the high-probability moves in this financial stock.

Right now, AHL is sitting up near resistance, which makes another move lower look likely. After that, investors should be looking for an opportunity to buy on the bounce off of trendline support.

If the stock’s in an uptrend, why wait? Well, the best time to buy a stock that’s in an uptrending channel comes at support -- it’s the place where shares have the furthest to move back up to resistance (the top of the channel) and where they have the least distance to move through support.

Since a breakdown below support means that the channel is broken, support is also a logical place to put a stop below to ensure minimal risk. The ideal AHL trade will take a little patience, but it should be rewarded in the end.

At the time of publication, author had no positions in stocks mentioned.

Jonas Elmerraji, based out of Baltimore, is the editor and portfolio manager of the Rhino Stock Report, a free investment advisory that returned 15% in 2008. He is a contributor to numerous financial outlets, including Forbes and Investopedia, and has been featured in Investor's Business Daily, in Consumer's Digest and on MSNBC.com.